FOMC Up Next As Oil Takes A Hit

Date | 18-09-2019 - 02:17 PM Article Type | Forex Region | United States

Oil has retraced sharply by more than 7% after Saudi Arabia’s full oil production capacity is expected to be restored within 2-3 weeks. The FOMC will now command the market’s attention, with the possibility of a 25bp rate cut around 85%. Interestingly, both high-beta and the risk-sensitive currencies lost value in absolute terms in the indices, with the European currencies taking up the slack.

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Quick Take
As the price of Oil adjusts lower on the appeasing words by the Saudi Arabia energy minister that the Kingdom is set to return to full oil production capacity within 2-3 weeks, the market is in the transition period to accommodate and expand its focal point to the FOMC. The market sees the possibility of a 25bp rate cut as almost baked in the cake, even if Chair Powell has definitely earned time to take it easy as the US economic data has firmed up and the expectations for another US-China trade truce build up. Ironically, with a squeeze in the short-term USD funding market as the spike in the repo rate reflects (shortage of USD supply), which has caused the Fed to step up by injecting liquidity into the system, there is even talk that given how tight the liquidity pool is to have sufficient USD liquidity in the system, considerations may be given to a light return of QE. Interestingly, it was a day when both the high-beta and the risk-sensitive currencies lost value in absolute terms in the indices, with the European currencies taking up the slack of gains. The CAD felt the damage of a falling Oil, as did the AUD to a dovish RBA minutes outcome. The NZD appears to be playing more catch up with the AUD here. The JPY and CHF were not in high demand as the risk appetite remains supportive, especially in equities even if no backing from global bond yields in the last couple of day.The GBP and the EUR can be found on the other side of the spectrum as said, both rising with conviction, while the USD loses its shine a bit ahead of the Fed verdict on policy. 

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Narratives In Financial Markets
* The Information is gathered after scanning top publications including the FT, WSJ, Reuters, Bloomberg, ForexLive, Institutional Bank Research reports.

Oil prices out protracted Saudi disruption: Oil has retraced sharply by more than 7% after Saudi Arabia’s full oil production capacity is expected to be restored within 2-3 weeks. Reuters front-run a story about oil production in Saudi Arabia back online at full capacity by the turn of the month, which was later confirmed by Saudi Energy Minister Salman, noting that production will reach 11m barrels per day by the end of September and full capacity of 12m barrels will be restored by the end of October.

Geopolitical tensions remain high: The US appears to have identified the exact locations in Iran from where the aggression via a joint attack of drones and missiles took place. VP Pence said the US military is ready after Saudi oil attacks and that the US is ready to defend their interests and that of the US allies. The VP said the best course of action is being assessed in the days ahead. Due to the escalation in geopolitical tensions, it justifies that Oil still carries a higher risk premium.

Spike in the repo market: An important event occurred in the repo market where rates spiked as high as 10% from just under 4% at the open, which forced the Fed to take action by providing around $53bn in additional liquidity via the overnight system repo. It’s the first time in a decade the Fed intervenes in the repo market, with another operation scheduled for Wednesday capped at $75b. There is a myriad of reasons that may have caused the spike in the short-term dollar funding market, from corporate debt issuance, quarterly tax payments, low reserve levels in the banking system, or even the Saudis pulling cash out of US markets to support their economy.

The FOMC to command the market’s attention: The market sees the possibility of a 25bp rate cut around 85%, with even some talk of a light return of QE given the issues with liquidity given the tightness in the Fed funds rate market. Another key focus will be the dot plot and obviously the type of rhetoric by Chair Powell in the press conference to get an update on whether the Fed still sees the cuts as part of a mid-cycle adjustment or a more long-lasting easing cycle.

US data prints solid numbers: Despite the US economic data published was of a second-tier nature, it reinforced the notion that the US economy remains in a firm footing outside the manufacturing sector. The US Industrial Production came stronger than expected in August at +0.6% m/m vs 0.2% expected. The NAHB housing market index also came on the bright side with a print of 68 vs 66, including an upward revision to 67 in the prior release. 

German ZEW not getting worse for now: In Germany, the ZEW survey came better than expected with the expectations component at -22.5 vs -38.0 expected, even if it must be read from a negative context. As Morgan Stanley’s Economist Markus Guetschow notes: “Current conditions continued to drop to a new post-crisis low. Industrial weakness is increasingly felt in the labor market, as the economy prepares to enter a technical recession in 3Q. The Ifo business climate is expected to fall further.”

RBA minutes imply the risk of near-term cut: The Australian Dollar was sold after the RBA minutes came more dovish than expected. While there was no real surprise but rather the confirmation that the RBA is going to be lower for longer. In the last paragraph, the reference to "accumulation of additional evidence" was dropped as the Central Bank focused on international as well as domestic conditions, most of all the labor market. Its forecasts seem to imply further easing will be necessary to support growth.

Author: PPS